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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
(Mark One)
[X]
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
[ ] OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
------------ -------------
Commission File Number 0-13084
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WARRANTECH CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3178732
- ------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2200 Highway 121, Suite 100, Bedford, TX 76021
- ----------------------------------------- ------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
--------------
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last year)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No ____
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at January 31, 2004
- --------------------------------------- -------------------------------
Common stock, par value $.007 per share 15,371,381 shares
WARRANTECH CORPORATION AND SUBSIDIARIES
I N D E X
Page No.
PART I - FINANCIAL INFORMATION --------
Item 1: Financial Statements
Condensed Consolidated Statements of Operations -
For the Three and Nine Months Ended December 31, 2003
and 2002 (Unaudited)................................................2
Condensed Consolidated Balance Sheets at December 31, 2003
(Unaudited) and March 31, 2003......................................3
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended December 31, 2003
and 2002 (Unaudited)................................................5
Notes to Condensed Consolidated Financial Statements.......................6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations .....................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..........18
Item 4. Controls and Procedures..............................................18
PART II - OTHER INFORMATION
Item 1: Legal Proceedings....................................................19
Item 2: Changes in Securities................................................19
Item 3: Defaults Upon Senior Securities......................................19
Item 4: Submission of Matters to a Vote of Security Holders..................19
Item 5: Other Information....................................................20
Item 6: Exhibits and Reports on Form 8-K.....................................20
Signature ....................................................................21
1
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Earned administrative fee (net of amortization of
deferred costs) $ 8,737,105 $ 9,342,900 $26,780,041 $28,315,303
----------- ----------- ----------- -----------
Costs and expenses
Service, selling, and general and administrative 7,582,779 7,404,622 23,113,507 22,501,844
Provision for bad debt expense 165,000 -- 425,000 --
Depreciation and amortization 718,893 835,427 2,539,866 2,880,081
----------- ----------- ----------- -----------
Total costs and expenses 8,466,672 8,240,049 26,078,373 25,381,925
----------- ----------- ----------- -----------
Income from operations 270,433 1,102,851 701,668 2,933,378
Other income 484,306 228,900 1,377,032 795,409
----------- ----------- ----------- -----------
Income before provision for income taxes 754,739 1,331,751 2,078,700 3,728,787
Provision for income taxes 301,113 307,424 628,372 1,101,574
----------- ----------- ----------- -----------
Net income $ 453,626 $ 1,024,327 $ 1,450,328 $ 2,627,213
=========== =========== =========== ===========
Earnings per share:
Basic $ 0.03 $ 0.07 $ 0.09 $ 0.17
=========== =========== =========== ===========
Diluted $ 0.03 $ 0.07 $ 0.09 $ 0.17
=========== =========== =========== ===========
Weighted average number of shares outstanding:
Basic 15,357,385 15,359,337 15,331,253 15,341,936
=========== =========== =========== ===========
Diluted 15,686,552 15,643,719 15,682,616 15,484,687
=========== =========== =========== ===========
See accompanying notes to condensed consolidated financial statements.
2
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, March 31,
2003 2003
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 2,973,860 $ 5,478,095
Investments in marketable securities 1,657,912 843,980
Accounts receivable, (net of allowances of
$640,607 and $230,064, respectively) 27,001,188 22,008,608
Loan receivable - Butler Financial Solutions, Inc. 13,320,598 8,612,678
Other receivables, net 6,773,077 5,299,887
Deferred income taxes 1,872,574 2,098,171
Employee receivables 58,834 73,833
Prepaid expenses and other current assets 1,257,298 1,218,392
----------- -----------
Total current assets 54,915,341 45,633,644
----------- -----------
Property and equipment, net 6,272,229 8,296,313
----------- -----------
Other assets:
Excess of cost over fair value of assets acquired
(net of accumulated amortization of $5,825,405) 1,637,290 1,637,290
Deferred income taxes 650,704 800,406
Deferred direct costs 5,312,889 9,972,309
Investments in marketable securities 710,820 1,355,263
Restricted cash 825,000 825,000
Split dollar life insurance policies 877,126 877,126
Notes receivable 7,387,250 5,411,653
Other assets 42,872 47,124
----------- -----------
Total other assets 17,443,951 20,926,171
----------- -----------
Total Assets $78,631,521 $74,856,128
=========== ===========
See accompanying notes to condensed consolidated financial statements.
3
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, March 31,
2003 2003
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital lease
obligations $ 707,587 $ 802,070
Insurance premiums payable 44,101,500 36,070,992
Income taxes payable 178,283 81,236
Accounts and commissions payable 7,226,472 8,118,371
Accrued expenses and other current liabilities 4,991,711 3,534,106
------------ ------------
Total current liabilities 57,205,553 48,606,775
------------ ------------
Deferred revenues 8,816,766 15,065,547
Long-term debt and capital lease obligations 1,122,976 1,218,670
Deferred rent payable 365,689 417,720
------------ ------------
Total liabilities 67,510,984 65,308,712
------------ ------------
Commitments and contingencies -- --
Stockholders' equity:
Preferred stock - $.0007 par value authorized - 15,000,000
Shares
issued - none at December 31, 2003 and March 31, 2003 -- --
Common stock - $.007 par value authorized - 30,000,000 Shares
issued - 16,558,988 shares at December 31, 2003 and
16,530,324 shares at March 31, 2003 115,915 115,714
Additional paid-in capital 23,779,669 23,760,809
Loans to directors and officers (10,676,516) (10,462,094)
Accumulated other comprehensive income (loss), net of taxes 34,070 (196,974)
Retained earnings 2,054,956 604,631
------------ ------------
15,308,094 13,822,086
Treasury stock - at cost, 1,187,607 shares at December 31, 2003
and 1,249,690 shares at March 31, 2003 (4,187,557) (4,274,670)
------------ ------------
Total Stockholders' Equity 11,120,537 9,547,416
------------ ------------
------------ ------------
Total Liabilities and Stockholders' Equity $ 78,631,521 $ 74,856,128
============ ============
See accompanying notes to condensed consolidated financial statements.
4
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Months Ended
December 31,
--------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income $ 1,450,327 $ 2,627,213
----------- -----------
Adjustments to reconcile net income to net cash
provided by operating 3,766,499 (2,565,078)
----------- -----------
Net cash flows provided by operating activities 5,216,826 62,135
----------- -----------
Cash flows from investing activities:
Property and equipment purchased (201,046) (2,179,395)
Purchase of marketable securities (920,000) (990,000)
Proceeds from sales of marketable securities 730,000 945,000
----------- -----------
Net cash used in investing activities (391,046) (2,224,395)
----------- -----------
Cash flows from financing activities:
Issuance of common stock 18,868 2,100
Purchase treasury stock -- (196,698)
Increase in loans and notes receivable (6,683,517) (791,953)
Repayments, notes and capital leases (665,366) (625,981)
----------- -----------
Net cash used in financing activities (7,330,015) (1,612,532)
----------- -----------
Net decrease in cash and cash equivalents (2,504,235) (3,774,792)
Cash and cash equivalents at beginning of period 5,478,095 7,033,448
----------- -----------
Cash and cash equivalents at end of period $ 2,973,860 $ 3,258,656
----------- -----------
Supplemental cash flow information:
Cash payments for:
Interest $ 497,816 $ 161,501
Income taxes $ 148,612 $(1,244,556)
----------- -----------
Non-cash investing and financing activities:
Property and equipment financed through capital leases $ 487,060 $ 115,745
Increase in loans to officers and directors $ (214,422) $ (228,045)
Issuance of treasury stock $ 87,113 $ 197,202
See accompanying notes to condensed consolidated financial statements.
5
WARRANTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
(UNAUDITED)
1. THE COMPANY
Warrantech, through its wholly owned subsidiaries, markets and administers
service contracts, extended warranties and replacement plans. The Company is a
third party administrator for a variety of dealer/clients in selected industries
and offers call center and technical computer services. The Company assists
dealer/clients in obtaining insurance policies from highly rated independent
insurance companies for all contracts and programs offered. The insurance
company is then responsible for the cost of repairs or replacements for the
contracts administered by Warrantech.
The Company's service contract programs benefit consumers by providing them with
expanded and/or extended product coverage for a specified period of time (and/or
mileage in the case of automobiles and recreational vehicles), similar to that
provided by manufacturers under the terms of their product warranties. Coverage
generally provides for the repair or replacement of the product, or a component
thereof, in the event of its failure. The Company's service contract programs
benefit the dealer/clients by providing enhanced value to the goods and services
they offer and by providing them with the opportunity for increased revenue and
income without the costs and responsibilities of operating an extended warranty
program.
The service contracts, extended warranties and replacement contracts generally
have terms ranging from three (3) to one hundred twenty (120) months. Since the
Company acts solely as a third party administrator on behalf of the
dealer/clients and insurance companies, the actual repairs and/or replacements
required under the agreements are performed by independent third party
authorized repair facilities or dealers. The cost of repairs is generally paid
for by the insurance companies which have the ultimate responsibility for the
claims or by Butler Financial Solutions, LLC ("Butler"), if Reliance Insurance
Company ("Reliance") or the Company is the obligor. The insurance policy
indemnifies the dealer/clients against losses resulting from service contract
claims and protects consumers by ensuring their claims will be paid.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by
management and are unaudited. These interim financial statements have been
prepared on the basis of accounting principles generally accepted in the United
States of America ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the
financial position and operating results of the Company for the interim period
have been included. Operating results for the three and nine months ended
December 31, 2003 are not necessarily indicative of the results that may be
expected for the fiscal year ending March 31, 2004. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended March 31, 2003.
3. RESTATEMENT
The Company's financial statements for the three months and nine months ended
December 31, 2002, have been restated to reflect a change in accounting
treatment in calculating net earned administrative fees as more fully described
in the Company's Annual Report on Form 10K for the year ended March 31, 2003.
For certain contracts, the Company previously had deferred a portion of the
revenue and would recognize such deferred revenue at the cancellation or end of
the contract's term. The Company is now recognizing this revenue over the life
of the contract's term.
6
The effect of this restatement for the three months and nine months ended
December 31, 2002 is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, 2002 DECEMBER 31, 2002
--------------------------------------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------------------------- --------------------------
Statement of operations:
Earned administrative fee (net of amortization
of deferred costs) $ 9,339,050 $ 9,342,900 $28,303,751 $22,315,303
Income from operations 1,099,001 1,102,851 2,921,826 2,933,378
Income before provision for income taxes 1,327,901 1,331,751 3,717,235 3,728,787
Provision for income taxes 306,049 307,424 1,097,456 1,101,574
Net income $ 1,021,852 $ 1,024,327 $ 2,619,779 $ 2,627,213
Earnings per share:
Basic $0.07 $0.07 $0.17 $0.17
===== ===== ===== =====
Diluted $0.07 $0.07 $0.17 $0.17
===== ===== ===== =====
4. NOTES RECEIVABLE
Butler serves as the ultimate obligor under predominantly all service contracts
administered by the Company in exchange for a fee. Some of the service contracts
under which Butler is the obligor were insured by Reliance and the liquidation
of Reliance has eliminated the insurance coverage to Butler.
To pay these Reliance obligations, the primary funding to Butler is provided by
a special surcharge, payable on certain vehicle service contracts administered
by the Company sold after November 19, 2001. The surcharge is payable by agents
through whom Reliance-insured service contracts were sold.
For any shortfall between the claims obligations being paid and the special
surcharge, Warrantech is assisting Butler by providing loans to Butler.
Warrantech Automotive made an initial $1 million loan to Butler and further
loans through December 31, 2003 of $19,731,095.
Additionally, it will continue to assist Butler in addressing its potential
obligations under the service contracts previously insured by Reliance for which
Butler is, or the dealer or Warrantech was, the obligor, by providing further
loans, as necessary, for claims obligations in excess of Butler's surcharge
revenues. Subject to the terms of the agreement between the Company and Butler,
the Company has and will make further loans to Butler, as necessary, for claims
obligations in excess of Butler's surcharge revenues. All of Warrantech's loans
to Butler bear interest at the rate of prime plus 2% per annum and will begin to
be paid down once Butler's fee revenues exceed the claims obligations.
Through December 31, 2003, Warrantech has loaned Butler $20,731,095. Of that
amount, Reliance Warranty Corporation ("RWC") is obligated to pay Butler
$13,320,598. On January 20, 2004, the Company collected the $13,320,598 from
RWC, which is reflected as a "Loan Receivable" on the Consolidated Balance
Sheet. The remaining amount representing the loans due from Butler of
$7,410,497 at December 31, 2003, is classified as "Notes Receivable" on the
Consolidated Balance Sheet (See Note 8).
The following table sets forth the carrying amounts and fair values of the
Company's notes and other receivables at December 31, 2003.
2004 2005 2006 2007 2008 THEREAFTER TOTAL FAIR VALUE
---- ---- ---- ---- ---- ---------- ----- ----------
Notes Receivable -
Butler Equals 2% above prime -- -- 2,563,129 $ 4,847,368 -- -- $ 7,410,497 $ 7,410,497
Loan Receivable - Butler;
Equals 2% above prime $13,320,598 -- -- -- -- -- $13,320,598 $13,320,598
7
5. COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income $ 453,626 $ 1,024,327 $ 1,450,328 $ 2,627,213
Other Comprehensive Income, net of tax:
Unrealized gains (losses) on investments (11,262) 1,703 (14,704) 20,123
Foreign currency translation adjustments 222,711 (39,535) 245,747 (46,641)
----------- ----------- ----------- -----------
Comprehensive Income $ 665,075 $ 986,495 $ 1,681,371 $ 2,600,695
=========== =========== =========== ===========
Comprehensive income per share $ 0.04 $ 0.06 $ 0.11 $ 0.16
=========== =========== =========== ===========
The components of accumulated comprehensive income, net of related tax, for the
periods ended December 31, 2003 and March 31, 2003, are as follows:
December 31, March 31,
2003 2003
------------ ---------
Unrealized gain on investments $ 3,343 $ 18,046
Accumulated translation adjustments 30,727 (215,020)
--------- ---------
Accumulated other comprehensive income $ 34,070 $(196,974)
========= =========
6. EARNINGS PER SHARE
The computations of earnings per share are as follows:
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------- -------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Numerator:
Net income applicable to common stock $ 453,626 $ 1,024,327 $ 1,450,328 $ 2,627,213
=========== =========== =========== ===========
Denominator:
Average outstanding shares used in the
computation of per share earnings:
Common Stock issued-Basic shares 15,357,385 15,359,337 15,331,253 15,341,936
Stock Options (treasury method) 329,167 284,382 351,363 142,751
----------- ----------- ----------- -----------
Diluted shares 15,686,552 15,643,719 15,682,616 15,484,687
=========== =========== =========== ===========
Earnings Per Common Share:
Basic $ 0.03 $ 0.07 $ 0.09 $ 0.17
=========== =========== =========== ===========
Diluted $ 0.03 $ 0.07 $ 0.09 $ 0.17
=========== =========== =========== ===========
8
7. STOCK OPTION PLAN
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of FASB Statement No. 123" (SFAS No. 148). SFAS No. 148 provides
alternative methods of transition for companies making a voluntary change to
fair value-based accounting for stock-based employee compensation. The Company
continues to account for its stock option plan under the intrinsic value
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. Effective for interim
periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure
of pro-forma results on a quarterly basis as if the Company had applied the fair
value recognition provisions of SFAS No. 123.
As the exercise price of all options granted under the plan was equal to or
above the market price of the underlying common stock on the grant date, no
stock-based employee compensation is recognized in net income. The following
table illustrates the effect on net income and earnings per share if the company
had applied the fair value recognition provisions of SFAS No. 123, as amended,
to options granted under the stock option plans and rights to acquire stock
granted under the company's Stock Participation Plan, collectively called
"options." For purposes of this pro-forma disclosure, the value of the options
is estimated using the Black-Scholes option pricing model and amortized ratably
to expense over the options' vesting periods. Because the estimated value is
determined as of the date of grant, the actual value ultimately realized by the
employee may be significantly different.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-----------------------------------------------------------------
2003 2002 2003 2002
--------------- --------------- -------------- -------------
Net income as reported $453,626 $1,024,327 $1,450,328 $2,627,213
Net income pro forma $426,311 $1,007,455 $1,387,096 $2,577,950
Shares - Basic 15,357,385 15,359,337 15,331,253 15,341,936
Basic earnings per share as reported $0.03 $0.07 $0.09 $0.17
Basic earnings per share pro forma $0.03 $0.07 $0.09 $0.17
The fair value of Warrantech stock options used to compute pro forma net income
and earnings per share disclosures is the estimated value at grant date using
the Black-Scholes option-pricing model with the following weighted average
assumptions for the three months and year ended December 31, 2003 and 2002,
respectively: expected dividend yield of 0%; expected volatility of 30% - 50%; a
risk free interest rate of 4.0% - 5.0%; and expected option life of 3 to 10
years.
Presented below is a summary of the status of the stock options in the plan and
the related transactions for the nine months ended December 31, 2003 and 2002.
2003 2002
--------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------------------------------------------
Options outstanding at beginning of the period 1,306,380 $1.10 1,416,283 $1.54
Granted 180,000 1.57 215,238 0.42
Canceled/Surrendered -- -- (5,000) (0.42)
Exercised -- -- -- --
Forfeited -- -- -- --
--------------------------------------------
Options outstanding at end of period 1,464,163 $1.93 1,581,521 $1.31
============================================
--------------------------------------------
Options exercisable at end of period 637,097 $1.34 610,111 $1.21
============================================
9
The weighted average fair value of stock options at date of grant, calculated
using the Black-Scholes option-pricing model, during the nine months ended
December 31, 2003 and 2002 was is $0.54 and $0.48, respectively.
The Company may issue options to purchase the Company's common stock to
officers, non-employees, non-employee directors or others as part of settlements
in disputes and/or incentives to perform services for the Company. The Company
accounts for stock options issued to vendors and non-employees of the Company
under SFAS No. 123 "Accounting for Stock-based Compensation." The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model is charged to operations utilizing weighted average
assumptions identical to those used for options granted to employees.
The following table summarizes the status of all Warrantech's stock options
outstanding and exercisable at December 31, 2003.
STOCK OPTIONS STOCK OPTIONS
OUTSTANDING EXERCISABLE
----------------------------- ---------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES PRICE SHARES PRICE
- ------------------------ -------------- ------------ ------------ ------------
$0.67 to $0.94 792,642 $0.69 382,404 $0.66
$1.26 to $1.595 700,231 $1.39 443,231 $1.33
$2.00 4,650,000 $2.00 3,000,000 $2.00
$3.25 to $3.375 101,290 $3.26 101,290 $3.26
-------------- ------------ ------------ ------------
Total at December 31, 2003 6,244,163 $1.79 3,926,925 $1.83
============== ============ ============ ============
On October 1, 2002, as part of an agreement between the Company and GAIC to
provide extended credit terms, GAIC received options to purchase up to 1,650,000
shares of common stock at an exercise price of $2.00 per share (the "GAIC
Options"). The GAIC options are exercisable between January 1, 2006 and December
31, 2006. In the event that Warrantech common stock price did not trade above $2
per share for ten consecutive trading days prior to January 1, 2004, the
exercise price of the option was automatically reduced to $1 per share.
Accordingly, the GAIC options were repriced to $1 per share on January 1, 2004.
Based on the Emerging Issues Task Force ("EITF") pronouncement number 96-18, the
repricing had no effect on the Company's Results of Operations. If GAIC
exercises all of these options, it would own approximately 10.8% of the
Company's outstanding shares.
8. SEGMENTS
The Company operates in three major business segments: Automotive, Consumer
Products and International. The Automotive segment markets and administers
extended warranties on automobiles, light trucks, motorcycles, recreational
vehicles and automotive components, which are sold principally by franchised and
independent automobile and motorcycle dealers, leasing companies, repair
facilities, retail stores, financial institutions and other specialty marketers.
The Consumer Products segment develops, markets and administers extended
warranties and product replacement plans on household appliances, consumer
electronics, televisions, computers, home office equipment, jewelry, musical
instruments and homes and which are sold principally through retailers,
distributors, manufacturers, utility companies, financial institutions and other
specialty marketers. Warrantech also markets these warranties and plans directly
to the ultimate consumer on behalf of the retailer/dealer and/or the
manufacturer through telemarketing and direct mail campaigns. The International
segment markets and administers predominately the same products and services as
the other business segments. The International segment is currently operating in
Central and South America, Puerto Rico and the Caribbean. "Other" includes
intersegment eliminations of revenues and receivables and net unallocated
corporate expenses.
10
CONSUMER REPORTABLE
NINE MONTHS ENDED AUTOMOTIVE PRODUCTS INTERNATIONAL SEGMENTS OTHER TOTAL
DECEMBER 31, 2003 ------------ ------------ ------------ ------------ ------------ ------------
- -----------------
Earned administrative fee
(net) $ 9,465,028 $ 13,008,780 $ 4,030,928 $ 26,504,736 $ 275,305 $ 26,780,041
Income (loss) from
operations 2,927,918 2,743,667 1,110,922 6,782,507 (6,080,840) 701,668
Pretax income (loss) (1,780,190) 1,424,799 1,150,093 794,702 (166,330) 628,372
Net interest income
(expense) (275,740) (37,136) 11,130 (301,746) 1,146,239 844,493
Depreciation/amortization 286,556 1,043,553 62,168 1,392,277 1,147,589 2,539,866
Total assets 44,919,002 21,458,946 4,740,008 71,117,956 7,513,565 78,631,521
DECEMBER 31, 2002
- -----------------
Earned administrative fee
(net) $ 14,661,922 $ 11,542,144 $ 2,349,442 $ 28,553,508 (238,205) $ 28,315,303
Income (loss) from
operations 8,726,480 1,512,693 75,092 10,314,265 (7,380,887) 2,933,378
Pretax income (loss) 3,357,804 (333,797) 69,565 3,093,572 635,215 3,728,787
Net interest income 20 (8,818) 7,567 (1,231) 524,160 522,929
Depreciation/amortization 284,360 1,276,497 64,480 1,625,337 1,254,744 2,880,081
Total assets 40,231,095 25,268,416 3,314,225 68,813,736 5,818,912 74,632,648
CONSUMER REPORTABLE
QUARTER ENDED AUTOMOTIVE PRODUCTS INTERNATIONAL SEGMENTS OTHER TOTAL
DECEMBER 31, 2003 ------------ ------------ ------------ ------------ ------------ ------------
- -----------------
Earned administrative fee
(net) $ 2,564,490 $ 4,981,853 $ 1,068,840 $ 8,615,183 $ 121,922 $ 8,737,105
Profit (loss) from
operations 471,704 1,714,119 148,199 2,334,022 (2,063,589) 270,433
Pretax income (loss) (1,185,091) 1,236,006 187,589 238,503 516,235 754,739
Net interest income 7,387 3,885 4,841 16,113 516,195 532,308
Depreciation/amortization 93,663 239,298 18,526 351,487 367,406 718,893
DECEMBER 31, 2002
- -----------------
Earned administrative fee
(net) $ 4,103,519 $ 4,439,082 $ 872,352 $ 9,414,953 ($ 72,053) $ 9,342,900
Profit (loss) from
operations 2,075,684 992,244 55,025 3,122,953 (2,020,102) 1,102,851
Pretax income (loss) 638,425 432,918 53,820 1,125,163 206,588 1,331,751
Net interest income 11,050 4,879 726 16,655 207,320 223,975
Depreciation/amortization 89,623 399,608 21,721 510,952 324,475 835,427
9. SUBSEQUENT EVENT
On January 16, 2004, as part of the Reliance Insurance Inc. bankruptcy
settlement, Reliance Warranty Company was acquired by Butler Financial
Solutions, LLC. Also, as part of the settlement, Staples and Warrantech agreed
to cancel Staples options to purchase 1,000,000 shares of Warrantech common
stock. Subsequently, on January 20, 2004 Reliance Warranty Company paid
Warrantech $13,910,622, which was due to Warrantech for claims paid by
Warrantech through that date, on behalf of Reliance Warranty Company. The cash
received by Warrantech was partially used to reduce its insurance premium
payables and increase available working capital.
11
WARRANTECH CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Except for the historical information contained herein, the matters discussed
below or elsewhere in this report on Form 10-Q may contain forward-looking
statements that involve risks and uncertainties that could cause actual results
to differ materially from those contemplated by the forward-looking statements.
The Company makes such forward-looking statements under the provisions of the
"safe harbor" section of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements reflect the Company's views and assumptions, based on
information currently available to management. Such views and assumptions are
based on, among other things, the Company's operating and financial performance
over recent years and its expectations about its business for the current and
future fiscal years. When used in this Quarterly Report on Form 10-Q, the words
"believes," "estimates," "plans," "expects," and "anticipates" and similar
expressions as they relate to the Company or its management are intended to
identify forward-looking statements.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, it can give no assurance that its
expectations will prove to be correct. These statements are subject to certain
risks, uncertainties and assumptions, including, but not limited to, (a)
prevailing economic conditions which may significantly deteriorate, thereby
reducing the demand for the Company's products and services, (b) availability of
technical support personnel or increases in the rate of turnover of such
personnel, resulting from increased demand for such qualified personnel, (c)
changes in the terms or availability of insurance coverage for the Company's
programs, (d) regulatory or legal changes affecting the Company's business, (e)
loss of business from, or significant change in relationships with, any major
customer, (f) the ability to successfully identify and contract new business
opportunities, both domestically and internationally, (g) the ability to secure
necessary capital for general operating or expansion purposes, (h) the adverse
outcome of litigation ,(i) the non-payment of notes due in 2007 from an officer
and two directors of the Company, (j) the inability of any of the insurance
companies which insure the service contracts marketed and administered by the
Company to pay the claims under the service contracts, (k) the inability of
Butler to pay the claims previously insured by Reliance, (l) the termination of
extended credit terms being provided by the Company's current insurance company,
(n) the outcome of the review currently being conducted by the staff of the
Securities and Exchange Commission ("SEC") of the Company's financial statements
and related disclosures, and (m) the Company's ability to expand its core
business and to increase its profit margin on its overall business.. Should one
or more of these or any other risks or uncertainties materialize or develop in a
manner adverse to the Company, or should the Company's underlying assumptions
prove incorrect, actual results of operations, cash flows or the Company's
financial condition may vary materially from those anticipated, estimated or
expected and there could be a materially adverse effect on the Company's
business.
SEC REVIEW OF THE COMPANY'S FILINGS
In March of 2003, the Staff of the Division of Corporation Finance of the SEC
selected certain of the Company's periodic reports for review, including the
Annual Report on Form 10-K for the fiscal year ended March 31, 2002 and the
Quarterly Reports on Form 10-Q for the periods ended June 30, 2002, September
30, 2002 and December 31, 2002. The staff informed the Company that the purpose
of the review is to assist the Company in its compliance with applicable
disclosure requirements and to enhance the overall disclosure in the Company's
reports.
In the course of its review, the staff requested clarification of some of the
Company's disclosures and items in its financial statements and the Company
agreed to amend certain of them on a going-forward basis. The Company also
amended certain of its disclosures as reflected in its Annual Report filed on
Form 10-K for the fiscal year ended March 31, 2003 and restated its financial
statements for prior periods to reflect certain changes in accounting policy.
The cumulative effect of the change to prior periods was a net benefit of
$1,721,184 to retained earnings.
The Company is still in discussions with the SEC Staff on the complex issues
regarding the Company's accounting treatment with respect to Butler Financial
Solutions, LLC ("Butler"), claims obligations under the service contracts
administered by the Company, consideration of consolidating Butler as a special
purpose entity and the recognition of revenue from the administration of service
contracts.
12
As a result of the comments from the SEC Staff, the Audit Committee of the
Company's Board of Directors retained a separate independent accounting firm to
review the accounting and disclosure issues raised by the SEC staff in its
comment letters and report to the Committee on its conclusions. The Audit
Committee received the report in December of 2003 ("the Special Accountant's
Report"). The Special Accountant's Report proposed different accounting
treatments than those utilized by the Company or raised by the SEC staff's
comment letters. The Company's regular independent auditing firm has informed
the Audit Committee that they concur with the accounting treatment used by the
Company.
After receiving the Special Accountant's Report, the Audit Committee submitted a
formal request to the SEC's Office of Chief Accountant for its views on the
issues over which there is disagreement. Representatives of the Company met with
the SEC staff to discuss the accounting issues, and the Audit Committee is
awaiting the SEC staff's views on these issues.
If the Company determines that it should follow the accounting treatment
recommended in the Special Accountant's Report, such changes could result in a
materially adverse change in the presentation of the Company's past financial
results, resulting in a restatement of prior period financial statements and
also of current shareholders equity, and a corresponding positive change in
future results. Since the accounting issues are still under review, the Company
has not made a determination at this time whether any such changes will be
required.
RESULTS OF OPERATIONS
GROSS REVENUES
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------------- -------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Automotive segment $ 22,552,246 $ 25,080,875 $ 80,575,476 $ 77,629,112
Consumer Products segment 12,082,939 10,785,133 32,427,210 28,217,706
International segment 2,103,230 1,592,983 6,664,611 4,106,799
Other (210,157) (72,052) (710,761) (238,203)
------------- ------------- ------------- -------------
Total gross revenues $ 36,528,258 $ 37,386,939 $ 118,956,536 $ 109,745,414
============= ============= ============= =============
Gross revenues for the three month period ended December 31, 2003 decreased
$858,681, or 2%, over the same period in 2002. The Automotive segment reported a
decrease in gross revenues of 10% in the three month period ended December 31,
2003 over 2002, due primarily from the loss of sales volume caused by weakness
in its core dealer business. Although gross revenues in Puerto Rico were down
due to the severance of the Company's relationship with an automotive insurance
carrier, the International segment experienced higher sales volumes in South
America, resulting in a $510,247 or 32% increase in the three month period ended
December 31, 2003. The Consumer Products segment also reported a 12% increase in
gross revenues during the three month period ended December 31, 2003, as sales
increased from its top customers and new customers.
Gross revenues for the nine month period ended December 31, 2003 increased
$9,211,122, or 8%, over the same period in 2002. The Automotive segment reported
a $2,946,364, or 4%, increase in gross revenue due to higher unit volumes in
both its reinsurance business and from direct marketers. For the nine month
period ended December 31, 2003, the International segment reported a $2,557,812,
or 62%, increase in revenues as the Company increased its customers' market
share. The Consumer Products segment also reported a 15% increase in gross
revenues during the nine month period ended December 31, 2003, as sales
increased from its top customers.
NET EARNED ADMINISTRATIVE FEES
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------ ------------ ------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Automotive segment $ 2,564,490 $ 4,103,519 $ 9,465,028 $ 14,661,922
Consumer Products segment 4,981,853 4,439,082 13,008,780 11,542,144
International segment 1,068,840 872,352 4,030,928 2,349,442
Other 121,922 (72,053) 275,305 (238,205)
------------ ------------ ------------ ------------
Total net earned
administrative fee $ 8,737,105 $ 9,342,900 $ 26,780,041 $ 28,315,303
============ ============ ============ ============
13
Net earned administrative fees are gross revenues less directs costs, the
combined sum of net premiums, commissions and sales allowances plus or minus
deferred revenue. Net earned administrative fees for the three months ended
December 31, 2003 were $8,737,105 compared to $9,742,900 for the same period in
the prior year. For the first nine months of fiscal 2004, net earned
administrative fees were $26,780,041 compared to $28,315,303 for the
corresponding period last year. The reduction in net earned administrative fee
for the three months and nine months ended December 31, 2003 was due primarily
to lower sales volumes in the Automotive segment and higher amounts of net
deferred revenue recognized last year. During the three month period ended
December 31, 2003, net deferred revenue was $404,238 compared to $985,033 in the
same period for 2002. For the nine months ended December 31, 2003, net deferred
revenue was $1,418,728 compared to $2,497,946 in the same period in the prior
year.
The Automotive segment's net earned administrative fee was $2,564,490 during the
third quarter of 2004, a reduction of $1,539,029 from the $4,103,519 net earned
administrative fee in the same quarter 2003. This resulted from a sales weakness
in its core business, lower margins due to product mix and lower net deferred
revenue recognized during the period. net deferred revenue for the third quarter
2004 was $315,383 compared to $821,665 in 2003. For the first nine months of
fiscal 2004, Automotive segment net earned administrative fee was $9,465,028
compared to $14,661,922 during the same period in 2003. This was the result of
lower volume resulting from sales weakness from its core business, lower margins
due to product mix and lower net deferred revenues recognized this period. For
the nine month ended December 31, 2003, net deferred revenue was $840,209
compared to $2,440,110 for the same period in the prior year.
The net earned administrative fee for the Consumer Products segment was
$4,981,853 in the third quarter of fiscal 2004, compared to $4,439,082 for the
same quarter in the previous year. For the nine-month period of fiscal 2004, net
earned administrative fees for the Consumer Products segment were $13,008,780
compared to $11,542,144 in the same 2003 period. The increase was due to higher
volumes from existing clients.
Net earned administrative fee for the International segment increased to
$1,068,840 in the third quarter 2004 from $872,352 for the same quarter in the
prior year. Although sales were down in Puerto Rico due to the Company's
severance of its relationship with an automotive insurance carrier, increased
volumes from existing clients in South America more than offset this loss. For
the first nine months of fiscal 2004, the International segment net earned
administrative fees were $4,030,928, up from $2,349,422 in the same period last
year. The increase in the International segment net earned administrative fee
was the result of increased volumes from new and existing clients and increased
market penetration in Puerto Rico during the first nine months of the fiscal
year.
SG&A
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Service, selling and general
administrative $ 7,582,779 $ 7,404,622 $23,113,507 $22,501,844
=========== =========== =========== ===========
Service, selling and general and administrative ("SG&A") for the quarter ended
December 31, 2003 increased $178,157, or 2%, compared to the same quarter in the
prior year. Employee costs were higher at $4,348,042 during the three month
period ended December 31, 2003, compared to $4,299,213 in the three month period
ended December 31, 2002, primarily due to higher health benefit costs. Rent
expense also increased from $328,055 for the three month period ended December
31, 2002 to $527,998 for the three month period ended December 31, 2003,
reflecting the Company's move to its new corporate headquarters in Bedford,
Texas and resulting in an overlap of leases.
For the nine month period, SG&A increased $611,663, or 3%, compared to the prior
year nine month period. Employee costs were slightly higher at $13,643,948
compared to $13,201,200 for the same period in the prior year, due to higher
health benefit costs and annual salary increases. Rent expense was up $567,734
as a result of the
14
overlap in leases for the new corporate facility. However, lower legal and
telephone expenses offset some of these increases. Legal expense was down
$884,419 due to the settlement of several lawsuits during fiscal period 2003.
Telephone expenses were reduced 21%, or $248,498, to $1,180,464 as compared to
$931,966 in the nine month period ended December 31, 2003, due to lower
negotiated telephone usage rates and the elimination of data transmission lines
after the Company consolidated operations into one building.
PROVISION FOR BAD DEBTS
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- -------------------------
2003 2002 2003 2002
-------- ---- -------- ----
Provision for Bad Debts $165,000 -- $425,000 --
======== ==== ======== ====
The Company increased its allowance for bad debts during fiscal year 2003 as it
anticipated the uncollectability of certain receivables from its Consumer
Products segment.
DEPRECIATION AND AMORTIZATION
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Depreciation and amortization $ 718,893 $ 835,427 $2,539,866 $2,880,081
========== ========== ========== ==========
Depreciation and amortization expenses were reduced by $116,534, or 14%, during
three month period ended December 31, 2003 compared to the same period for 2002
and $340,215, or 12%, during the nine month period ended December 31, 2003
compared to the same period for 2002. This decrease is the result of the
Company's assets maturing and the continued reduction of capital expenditures
for the past few years.
OTHER INCOME
FOR THE THREE MONTHS ENDED FOR THE YEARS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Interest and dividend income $ 532,308 $ 223,975 $ 1,342,309 $ 684,430
Interest expense (217,261) (73,962) (497,816) (161,501)
Gain (loss) on sale of assets -- -- 2,976 (57,459)
Credit card usage rebate 120,000 72,000 337,177 319,348
Miscellaneous income 49,259 6,887 192,386 10,591
----------- ----------- ----------- -----------
Total other income $ 484,306 $ 228,900 $ 1,377,032 $ 795,409
=========== =========== =========== ===========
Other income for three and nine months ended December 31, 2003 increased
compared to the three and nine months ended December 31, 2002. Higher interest
income, primarily from the Butler notes and loans receivable was partially
offset by higher interest expense incurred from the Company's extended payment
terms for its insurance premium payable. Miscellaneous income was higher, as a
result of sublease of the Company's former location which will cease after March
2004. Both interest expense and interest income should be lower in the fourth
quarter and the following year as a result of Butler paying down the $12.2
million Other Receivable and the Company not extending credit on its insurance
premiums.
INCOME TAX EXPENSE
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Income taxes expense $ 301,113 $ 307,424 $ 628,372 $1,101,574
========== ========== ========== ==========
15
Income taxes expense decreased $473,202 for the nine month period ended December
31, 2003 compared to the period ended December 31, 2002, primarily due to a
reduction in income before taxes and a lower effective tax rate from its
International segment.
LIQUIDITY AND FINANCIAL RESOURCES
During the nine months ended December 31, 2003, the Company had a net increase
in cash flows from operating activities of $5,216,826, which was primarily used
in financing activities to fund the Bulter loan and notes receivable. During the
nine months ended December 31, 2003, the Company used $391,046 in investing
activities compared to the use of $2,224,395 in the prior year. This decrease
results primarily from the purchase of property and equipment in the prior year,
which was related to the move by the Company into its new Headquarters facility.
Working capital was a negative $2.3 million at December 31, 2003, unchanged from
the negative $2.3 million at December 31, 2002. The Company believes that
internally generated funds, the collection on January 20, 2004 of $13,910,622
from RWC and the $3 million line of credit from Great American Insurance
Company, will be sufficient to finance its current operations for at least the
next twelve months. In addition, the Company is aggressively pursuing new
business both domestically and internationally to fund future working capital.
The Company plans to continue to contain its SG&A costs and utilize technologies
for operational efficiencies to further enhance both its operating income and
cash flows from operating activities.
The Company has ongoing relationships with equipment financing companies and
intends to continue financing certain future equipment needs through
lease/purchase transactions. The total amount financed through these
transactions during the nine months ended December 31, 2003 amounted to $487,060
compared to $115,745 during the nine months ended December 31, 2002.
Effective April 1, 2003, the Company entered into an office lease in Puerto Rico
for 3,433 square feet This lease, which expires March 31, 2005, provides for
annual rent of $61,794. Effective November 26, 2003, the Company amended its
Bedford Texas office lease to expand its leased space from 56,696 square feet to
67,811 square feet. This lease, which expires in February 2013, provides for
annual rent of $1.2 million.
On December 18, 2003 the Company obtained a $200,000 irrevocable standby letter
of credit from Bank One for the benefit of its merchant credit card processor.
This letter of credit, issued for one year, automatically renews annually.
OUTLOOK
The Company continues to improve customer service and technology utilizing its
web-based platform, which provides real-time capabilities that meet the needs of
dealers, service providers and consumers. It is designed to reduce paperwork and
the time and costs of administering warranties for dealers and service
providers, while providing a better experience and faster service for their
customers. New modules for the application include Service Contract Submission,
Dealer Sales Analysis and Express Claims Processing The Service Contract
Submission module is designed for smaller dealers that typically do not generate
high volumes. It allows them to enter contract sales and registration data in
"real time" to Warrantech via the Internet. This module is an appropriate
complement to Warrantech's existing electronic data acquisition modules for
medium and large-sized dealers.
Dealer Sales Analysis allows retailers to graphically display service contract
sales history by store location and/or product class, charting categories such
as retail sales dollars, margin dollars and unit counts. The information
supporting any graphical display can also be downloaded for further in-house
analysis. The Express Claims Processing feature allows service centers to submit
their repair invoices to Warrantech in two ways. Claims can be keyed into the
site individually or a file of claims can be uploaded, depending upon volumes on
any given day. Significant enhancements to the existing Express Service and
External Servicer Interface modules were also made. Service centers can
electronically request Warrantech to assist in locating a customer's contract,
modify an existing contract or increase an existing repair authorization.
16
The Company's Consumer Products segment expects a slight increase in net earned
administrative fees, as a result of additional store openings by several of its
largest customers. To address the weakness in the Automotive segment, the
Company recently announced several new warranty programs which it anticipates
will help to reverse a recent downward trend in sales volumes. After increasing
sales volumes during the past year, primarily as a result of its new reinsurance
program, the Automotive segment sales volumes experienced an unexpected decline
in the prior quarter that is anticipated to continue through the end of the
fiscal year.
The International Segment continues to improve its sales volume in South
America, which is anticipated to offset the loss of automotive volumes in Puerto
Rico. The International segment expects to introduce a new automotive warranty
program in Puerto Rico during the first half of next fiscal year.
SIGNIFICANT EVENTS
On September 19, 2003, the Company announced that the Board of Directors had
received a proposal by its founder, Mr. Joel San Antonio, to take the Company
private. Mr. San Antonio's proposal involved cashing out all minority
shareholders at a price of $1.65 per share by means of a reverse stock split.
The proposal was subject to securing financing and did not address other details
concerning the Company's capitalization.
On December 15, 2003, the Company announced that Mr. San Antonio, had withdrawn
his proposal. Mr. San Antonio, in explaining the reason for withdrawing the
proposal, advised the Board of Directors that he believed that the Company
should focus its efforts on resolving the outstanding accounting issues and
improving the Company's business and operations in order to achieve greater
value for its shareholders.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the dates
of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Note 1 to the Company's Consolidated Financial
Statements set forth in the "Item 8. - Financial Statements and Supplementary
Data," in the Company's Annual Report on Form 10-K for the year ended March 31,
2003, describes the significant accounting policies and methods used in the
preparation of the Consolidated Financial Statements. The following lists some
of the Company's critical accounting policies affected by judgments, assumptions
and estimates.
REVENUE RECOGNITION
Under SAB 101, the Company recognizes revenue when the revenue is realizable and
earned. The Company considers revenue realized and earned when a definitively
discrete earnings event has occurred. The Company has two discrete earnings
events (1) for marketing and administration of service contracts and (2) for
servicing fees. The marketing and administrative fee is paid by the retailer of
the service contract. This revenue is recognized at the time of the sale to the
retailer as the Company will have substantially completed the services it has
agreed to provide in connection with the sale of the service contract to the
consumer. The second discrete earnings event occurs over the life of the
contract. As such, Warrantech recognizes and realizes the revenue over the
contract life.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company assesses potential impairment of its long-lived assets, which
include its property and equipment and its identifiable intangibles such as
software development costs, goodwill and deferred charges under the guidance of
SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." Once
annually or as events or circumstances indicate that an asset may be impaired,
the Company assesses potential impairment of its long-lived assets. The Company
determines impairment by measuring the undiscounted future cash flow generated
by the assets, comparing the result to the assets' carrying value and adjusting
the assets to the lower of their carrying values or fair values and charging
current operations for any measured impairment. At December 31, 2003 and 2002,
the Company found no impairment to its property and equipment or its other
identifiable intangibles.
17
INCOME TAXES
Deferred tax assets and liabilities are determined using enacted tax rates for
the effects of net operating losses and temporary differences between the book
and tax bases of assets and liabilities. The Company records a valuation
allowance on deferred tax assets when appropriate to reflect the expected future
tax benefits to be realized. In determining the appropriate valuation allowance,
certain judgments are made relating to recoverability of deferred tax assets,
use of tax loss carryforwards, level of expected future taxable income and
available tax planning strategies. These judgments are routinely reviewed by
management. At December 31, 2003, the Company had deferred tax assets of
$2,523,278, net of a valuation allowance of $174,452. For further discussion,
see Note 12 to the Consolidated Financial Statements in the Company's Annual
Report on Form 10-K for the year ended March 31, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2003, the Company did not have any derivatives, debt or
hedges outstanding. Therefore, the Company was not subject to interest rate
risk. In addition, the risk of foreign currency fluctuation was and is not
material to the Company's financial position or results of operations.
Short-term marketable securities and long-term investments are comprised of
municipal bonds which bear interest at fixed rates. Interest income from these
securities is generally affected by changes in the U.S. interest rates. The
following tables provide information about the Company's financial instruments
that are sensitive to changes in interest rates. The tables present principal
cash flows and weighted-average interest rates by expected maturity dates. All
of the investments are considered "available for sale." The resultant
differences between amortized cost and fair value, net of taxes, have been
reflected as a separate component of accumulated other comprehensive income.
Principal amounts by expected maturity as of December 31, 2003 of marketable
securities are as follows:
Expected Maturity Date as of December 31,
---------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total Cost Fair Value
---- ---- ---- ---- ---- ---------- ---------- ----------
Available for sale
securities $1,635,000 $520,000 $170,000 -- -- -- $2,325,000 $2,325,000
Interest rate 3.14% 3.75% 2.63% -- -- --
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO)
are primarily responsible for the accuracy of the financial information that is
presented in this Quarterly Report on Form 10-Q. Each of them has, within 90
days of the filing date of this Quarterly Report, evaluated the Company's
disclosure controls and procedures, as defined in the rules of the SEC, and have
determined that such controls and procedures were effective in ensuring that
material information relating to the Company and its consolidated subsidiaries
was made known to them during the period covered by this Quarterly Report.
INTERNAL CONTROLS
To meet their responsibility for financial reporting, the CEO and CFO have
established internal controls and procedures which they believe are adequate to
provide reasonable assurance that the Company's assets are protected from loss.
These internal controls are reviewed by the Company's independent accountants to
support their audit work. In addition, the Company's Audit Committee, which is
composed entirely of outside directors, meets regularly with management and the
independent accountants to review accounting, auditing and financial matters.
This Audit Committee and the independent accountants have free access to each
other, with or without management being present.
THERE WERE NO SIGNIFICANT CHANGES IN THE COMPANY'S INTERNAL CONTROLS OR IN
OTHER FACTORS THAT COULD SIGNIFICANTLY AFFECT INTERNAL CONTROLS SUBSEQUENT TO
THE DATE OF THE CEO'S AND CFO'S MOST RECENT EVALUATION.
18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
LLOYD'S UNDERWRITERS
Certain Underwriters at Lloyd's, London and Other Reinsurers Subscribing to
Reinsurance Agreements F96/2992/00 and No. F97/2992/00 v. Warrantech
Corporation, Warrantech Consumer Product Services, Inc., Warrantech Help Desk,
Inc., and Joel San Antonio, District Court of Tarrant County, Texas, 17th
Judicial District.
During the period that Houston General was the underwriter of certain of
Warrantech's programs, it reinsured certain of the underwritten risks with one
or more Lloyd's insurance syndicates. At some point thereafter, Houston General
commenced an arbitration against the Lloyd's syndicates seeking to recover
approximately $46,000,000 under the reinsurance treaties with respect to claims
previously paid by Houston General on warranty claims submitted by customers
under Warrantech programs. The Warrantech entities were not parties in the
arbitration but were the subject of extensive discovery by each of Houston
General and the Lloyd's syndicates. The arbitration concluded in August 2002
with an award of approximately $39,000,000 in favor of Houston General.
The award supports the assertions of Houston General with respect to the
validity of the claims that it paid. Warrantech was not involved in the
selection of these re-insurers, has no contractual relationship with them, and
has had no reporting or other obligation to them. Despite these facts, the
Lloyd's syndicates now seek to recover some portion of the arbitration award
from the Warrantech entities on two theories of liability. The first is that, at
the time certain claims were presented to Houston General for payment, the
Warrantech entities either fraudulently or negligently represented to Houston
General that such claims were valid. The second is that the Warrantech entities
intentionally failed to comply with their legal obligations to cooperate with
the parties during the discovery process for the arbitration. The complaint
seeks ordinary, punitive and exemplary damages although no specific amount is
requested. On January 6, 2004, the plaintiff filed an amended complaint that
adds Joel San Antonio, Chairman and Chief Executive Officer of Warrantech
Corporation, as a party defendant in his individual capacity.
Warrantech has filed a counterclaim against Lloyd's arising out of the same set
of facts that underlie the original litigation. Warrantech alleges fraud, unfair
claim settlement practices and bad faith and is seeking damages of approximately
$46 million. Warrantech is also asking that treble damages for $138 million be
awarded as permitted under applicable Texas law.
The parties are presently engaged in extensive document discovery and the taking
of depositions.
Management believes that this case is without merit; however, it is not able to
predict the outcome of this litigation. The Company is unable at this time to
determine the Company's potential liability, if any, and as such, the
accompanying financial statements do not reflect any estimate for losses.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to Vote of Security Holders
Not applicable.
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Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to
Section 302 of Sarbanes-Oxley Act.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of Sarbanes-Oxley Act.
32.1 Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant to
18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of Sarbanes-Oxley Act.
(b) Reports on Form 8-K
1. Current Report on Form 8-K, dated November 6, 2003,
reporting, under Item 9, `Regulation FD Disclosure,' the
Company's financial results for the quarter ended September
30, 2003.
2. Current Report on Form 8-K, dated December 15, 2003,
reporting, under Item 5, `Other Events and FD Disclosure,'
that Mr. Joel San Antonio, had withdrawn his proposal to take
the Company private.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WARRANTECH CORPORATION
(Registrant)
/s/ Richard F. Gavino
-----------------------------------
Richard F. Gavino - Executive
Vice President, Chief Financial
Officer, Chief Accounting Officer
and Treasurer (Chief Financial
Officer and Duly Authorized Officer)
Dated: February 12, 2004
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